Legalized Marijuana & Multi-Jurisdictional Banking: High Times for Community Banks

Small local institutions have less regulatory risk in serving marijuana businesses in states where they are legal.

Regulations in the financial industry, while often complex in the detail, are straightforward at a high level regarding what the government is asking a financial institution to do. Don’t finance the sale of uranium to Iran; do extra due diligence on large wire transactions to Mexico, etc. However, with the recent legalization of the sale of marijuana in Colorado, California, and other states, financial institutions find themselves in a gray area with no clear answers on whether they are able to service this industry.

On one hand, state laws allow for the legal sale of marijuana while, on the other hand, in most states and on a federal level, the sale of marijuana is still illegal. Thus business owners in these states are faced with different experiences depending on the financial institution with which they work. Large multi-state banks are predominately taking a conservative approach to the marijuana business and choosing not to provide services to the industry, based on federal legislation. This ranges from not providing checking and merchant acquiring services even extending to not underwriting commercial loans on buildings that rent space to marijuana businesses. The banks have taken this position because potential profit in working in this industry does not match the risk associated with it from potential federal fines and other penalties.

Local banks within these states, however, are taking a much different approach. Community banks and credit unions that are located completely within a state’s borders often do not face the same threats from federal or other states' regulators when working in this industry. Suddenly they are noticing that a large commercial industry is not being served and there is very little competition from other financial service providers. Thus many of them have decided to approach this industry aggressively as there are billions of dollars at stake.

These smaller, more local financial institutions are not off the hook, as they have to apply extra due diligence to these types of businesses. Part of this is due to the legalized marijuana industry being a cash-intensive business, which requires extra scrutiny around sources of funds, but also because shops that are located near state borders could potentially enable the sale of illegal goods. For example, a shop on the Colorado/Utah border would be very high risk because if the sale of marijuana occurs in Utah, the financial institution would be facilitating illegal transactions.

This multi-jurisdictional issue is not just limited to the marijuana business, but the recent legalization has highlighted issues around these types of businesses within the US. It appears the topic is only going to get more complex, with other states looking to legalize marijuana and potentially other high-risk businesses, like gambling, at the state level. However, these businesses can be a boon to the local banking community, which should be able to capitalize on the liberalization of state regulations.

Robert McKay is a managing director for Accuity, where he manages the risk and compliance product solutions and oversees the firm's global partnerships. McKay is an authority on the issues facing organizations in increasing payment straight through processing rates and ... View Full Bio

I've read businesses have expanded around marijuana, like traditional bakeries that now also offer MJ-infused cookies or lollipops. I think by even dabbling or extending into drug markets they are putting themselves at risk with banks they've been working with for years. Local banks definitely have an opportunity to take on their business while the big players work out these kinks.

The anonymity that Bitcoin offers would't have any advantage in terms of buying marijuana there since it's legal anyway. That doesn't preclude someone from wanting to use it to buy something else. So I was talking more from a legal perspective than from a consumer perspective I guess.

That implies that the primary use for bitcoins/virtual currencies is for illegal transactions (or at least transactions where anonymity is preferred). Maybe that's true, but I don't think bitcoin proponents would advocate that view.

It is nice to see the community banks in Colorado get a head start in grabbing business from the legalized marijuana business. Not only is it a great new revenue stream for the banks, but it is much needed. Since the industry is primarily cash, it is a perfect target for crime (and money laundering). So, bringing the business into community banks is a good first step.

I'm sure you're right. I think that inevitably is going to start happening in less "controversial" areas such as mobile payments. Sooner or later the CFPB and others will turn their attention to the new non-bank players and work to hold them to the same standards/rules as banks. Then the bloom will be off the rose for them.

I think if non-bank providers tried to take some of these businesses on as customers, they would very quickly draw the attention of regulators, and might find themselves under some intense scrutiny very quickly.

Really interesting update on how this new business segment is being served, Robert. Despite all their complaints about being over-regulated there definitely are significant areas where community banks have competitive/operational advantages over bigger financial institutions. It's also interesting that this has happened so quickly -- but that makes sense, because I would imagine that legal marijuana commerce is another area that non-traditional/non-bank players may view as an opportunity. If consumers are increasingly "unbanked" by choice, no reason that the same couldn't apply to small businesses. So the window of opportunity is now.